The recent case of Mrs Bower (deceased) v HM Revenue & Customs had clouded the issue of when they can be used but a final decision from the High Court in April has clarified the situation and ought not to detract from their use where appropriate.
A discounted gift trust allows the settlor to put a lump sum into trust for their beneficiaries but still allows them to retain rights to regular payments.
There are broad-ranging advantages on offer via DGTs, including the potential for any regular payments out of the trust being free of an immediate income tax liability.
Importantly, DGT arrangements can immediately reduce the size of the client’s estate for IHT calculation purposes.
There is a broad choice of bonds for clients to choose from, including onshore and offshore, with mixes to suit the range of risk profiles and with the added benefit that investment growth will be considered outside of the estate for IHT purposes.
While the settlor is alive, they can expect regular payments, with the size and frequency of their choosing and it is also possible for their beneficiaries to take payments at the discretion of the trustees.
The case of Bower v HMRC was over the upper age limit for settlors of DGTs.
In April, HMRC confirmed it had won its appeal against a Special Commissioner’s decision in the case and that its original position – that there should be no discount available for very elderly settlors – would stand.
The case concerned a DGT from Axa taken out by Mrs Bower, aged 90, who died just a few months after establishing the trust.
Axa assessed her life expec- tancy when she took out the trust to be 103 years and, on this basis, quoted a discount of £7,800 but the Revenue argued its value should only have been a nominal technical amount of just £250.
Within a DGT arrangement, the way the discount is worked out takes into account the number of payments the client is likely to receive during their lifetime. This means the size of the gift likely to remain within the trust once the settlor’s regular payments have been deducted depends not only on the size and frequency of these payments but also the life expectancy of the settlor.
Roughly speaking, the longer they are expected to live, given their current age, state of health and gender, the more payments they could expect to get and the discounted value of the gift is likely to be smaller.
Conversely, if someone is older and not in good health when the trust is established, the value of the gift might not be discounted greatly and establishing the trust will be less advantageous.
HMRC’s argument – a position it made clear in a technical note issued back in May 2007 – is that it is the open market value of the rights retained by the settlor will depend on their insurability.
To put it another way, would a prudent insurer want to buy the retained rights of the settlor to their regular payment? If the settlor were to be uninsurable at the time they made the gift, the open market value of the retained rights would be nominal and the gift would be close to the whole amount invested by the settlor.
In Mrs Bower’s case, HMRC argued that there would be a nominal discount – the £250 figure – as no insurer would be likely to quote her for life cover, given her age.
The High Court’s ruling in favour of HMRC’s appeal was highly critical of the Special Commissioner’s ruling and, in particular, the way that the value of the discount relating to Mrs Bower’s plan had been devised.
The Special Commissioner had used his own calculations to determine a discount of £4,200, prompting the High Court ruling to detail how he had been wrong to introduce his own method and also said that the Special Commissioner “had gone wrong in law” in deciding there would have been a buyer who would be prepared to purchase the right to Mrs Bower’s regular monthly payment.
The High Court’s decision is final and confirms as correct the basis on which HMRC values the retained rights in DGTs where the settlor is older than 90 next birthday (this could be actual age or rated age following underwriting), or where the settlor is considered to be uninsurable at the transfer date, as featured in the May 2007 technical update.
Now that the Bower case has been settled, HMRC will begin to process those cases on hold which have been directly affected by the High Court’s final ruling.
Using the HMRC’s May 2007 guidance, if HMRC’s actuarial team consider the value of retained rights in a DGT is only nominal because of the age of the donor or because the donor is considered to be uninsurable, it says it will advise those liable for the IHT accordingly.
It says it will not press for payment of the additional IHT for the time being but suggests executors should consider putting an appropriate sum on account to stop interest accruing on any IHT due.
In terms of the implications for financial services firms of the Bower ruling, Friends Provident points out it is unlikely that the few providers that marketed schemes for the over-90s will continue to do so now there can be no meaningful discounts.
However, the ruling has led to some product development. Recently, when marketing the expanded age range of its discounted gift plan, Standard Life said the move was in response to both demand and the clarity resulting from the Bower case.
Standard Life now offers customers who are not aged (and not age-rated) over 89 the reassurance of being able to make a gift to one of its discounted gift plans and receive a personalised discount certificate after underwriting.
It insists that its customers must be no older than 89 years and six months at point of application in order to allow enough time for the medical underwriting process to be completed, an important issue also highlighted by the Bower case.
Few advisers may have cases directly relating to the implications of the Bower appeal but there are broader implications for anyone involved in establishing a DGT for older clients.
HMRC says the open-market-based valuation method requires that evidence of the settlor’s health exists at the transfer date. This evidence also needs to be to the same standard as one would expect in order for the settlor’s life to be underwritten for whole of life assurance.If evidence of health to this standard has not been obtained at the outset, HMRC warns it might take the view that a discount is not justified.
The Revenue says it adopts this stance because of the many problems that can arise where no evidence of health has been obtained at the outset. On the death of a settlor, for example, HMRC will often need to ask the settlor’s personal representatives to obtain evidence about the settlor’s health at the time the gift was made.
The Revenue says it recognises that this is undesirable as the surviving family may face intrusive and upsetting enquiries at a difficult time but says this can be avoided if the information is obtained in advance.
HMRC also suggests that problems can arise where medical evidence is not collected until after the transfer occurs and at that stage it becomes apparent that up to date medical details are not held and the situation could result in no discount.
The Bower case demonstrates the importance of the insurability and securing the proof of the settlor’s life when it comes to calculating discounts but the news over nominal discounts should not prevent advisers from recommending a DGT if this seems appropriate for their clients’ tax planning needs.